Keyman Insurance protects your business against the loss of a key member of staff should they die or suffer a critical illness. It will pay out a cash lump sum into the business so the company can cope with any turbulence during such a loss. It can help with:
The below is a general guide to HMRC’s taxation of Key Person Cover, although if there’s any doubt you should always check with your accountant and / or your local tax office.
How Key Man Insurance is taxed is a complicated business governed by a set of guidelines laid out more than 70 years ago known as the Anderson Rules.
One of these guidelines is the ‘wholly and exclusively test‘, which is one of the major factors in deciding whether or not you pay tax on Keyman Insurance premiums.
The wholly and exclusively test looks at whether the payout from the policy will be ‘wholly and exclusively for the purposes of the company’s trade’, i.e. solely for the benefit of the business. If so, premiums are typically a tax-deductible business expense against the company’s corporation tax bill.
Where a policy would benefit the company shareholder the purpose of the policy fails the ‘wholly and exclusively’ test and premiums are therefore unlikely to be eligible for corporation tax relief.
According to HMRC’s Business Income Manual at BIM45530:
“Where the key person is a director whose death would significantly affect the value of shares in the company, one of the purposes for taking out the policy may be a non-trade purpose of protecting the value of the director’s shares and therefore the value of their estate … [and are] not paid wholly and exclusively for the purposes of the company’s trade.”
There may be some ‘wiggle room’ for minority shareholders who own around 5% or less of the company. This limit isn’t statutory – it’s more of a guideline and may be open to negotiation with HMRC on a case-by-case basis.
Payouts on plans that cover company shareholders usually count as a trading receipt, which means that they’ll also be taxed. So it’s worth remembering that policies that benefit shareholders could be taxed on the way in and on the way out.
When Keyman Insurance is taken out to cover an employee, premiums are typically a tax-deductible business expense eligible for corporation tax relief. This is because the payout is not for the benefit of the employee but for the business to make up for the loss of that key person.
The benefit usually counts as a trading receipt and will therefore be taxable. Where benefits are taxable, you’ll need to gross up the payout to ensure that the net figure you receive post-tax will still meet your needs.
When you take out a Key Person Insurance policy specifically to protect a business loan, premiums again fail the ‘wholly and exclusively’ test because the payout isn’t for the business – it’s for the benefit of the lender. This means that you’ll need to pay tax on the premiums covering business loans.
However, given the payout is intended to rebalance the company’s capital account it’s not classed as a trading receipt and so is usually paid tax-free. This means that there’s no need to gross up the value of such policies, which naturally reduces the premium.
As a general rule of thumb, where you get tax relief on Keyman Insurance premiums, the benefit will be taxable to compensate and vice versa.
However, this isn’t always the case, such as where the policy covers a shareholder, so it’s always best to check the ins and outs with your accountant and HMRC.
Business Protection Expert at Drewberry
Drew was incredibly helpful all the way along and very responsive and patient with any questions I had (which were many). He was able to get me a much better deal on my new health insurance than I had been able to get online. A success all round!